How to Pay Yourself From a Business Account

Paying yourself from a business account requires understanding your business structure and its tax implications. Managing these payments properly ensures accurate financial records and compliance with tax regulations. Separating business and personal finances from the outset provides a foundation for sound financial management. The method you use to pay yourself depends on your business’s legal structure.

Owner Payments for Sole Proprietors and Single-Member LLCs

For sole proprietorships and single-member LLCs, the business is not a separate legal entity from its owner for tax purposes. Business income and expenses are reported on the owner’s personal tax return, using Schedule C, Profit or Loss From Business. The primary method for an owner to take money from the business is an “owner’s draw.”

An owner’s draw involves directly transferring funds from the business bank account to the owner’s personal bank account. This transfer is not a business expense and is not tax-deductible for the business. All net earnings are subject to self-employment taxes, including Social Security and Medicare taxes, regardless of whether the funds are drawn. The self-employment tax rate is 15.3%, comprising 12.4% for Social Security and 2.9% for Medicare, applied to 92.35% of your net earnings from self-employment.

No W-2 form is issued to the owner. Instead, the owner pays self-employment taxes on the business’s profits when filing their personal income tax return. Establishing a separate business bank account helps avoid commingling personal and business funds, simplifying record-keeping and tax preparation.

Owner Payments for Partnerships and Multi-Member LLCs

Partnerships and multi-member LLCs operate as “pass-through” entities. The business itself does not pay income tax; instead, profits and losses pass through to individual partners or members, who report their share on personal tax returns. Payments to owners can take two forms: guaranteed payments and distributions.

Guaranteed payments are fixed amounts paid to partners or members for services or use of capital, similar to a salary. These payments are a deductible expense for the partnership, reducing its taxable income. The receiving partner or member must report these payments as taxable income and are subject to self-employment taxes.

Distributions represent a partner’s or member’s share of the business’s profits. These are not deductible expenses for the partnership and are generally not subject to self-employment taxes for the recipient. Partners and members receive a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., detailing their share of income, deductions, and credits, including any guaranteed payments and distributions. The process for making payments involves electronic transfers or checks from the business account to personal accounts.

Owner Payments for S Corporations

S Corporations differentiate between a reasonable salary and distributions for owner compensation. The Internal Revenue Service (IRS) requires S Corporation owner-employees to pay themselves a “reasonable salary” for services provided to the corporation. This salary is subject to all applicable payroll taxes, including federal, state, and local income taxes, as well as Social Security and Medicare taxes, like any other employee’s wages.

Determining a “reasonable salary” is important for S Corporation compliance, as the IRS may reclassify distributions as wages if the salary is too low. Factors considered by the IRS include the owner’s training and experience, duties and responsibilities, time and effort devoted to the business, and compensation for similar roles in comparable businesses. After paying a reasonable salary, any remaining profits can be taken as distributions, up to the owner’s basis in the company. These distributions are not subject to self-employment taxes, offering a potential tax savings compared to sole proprietorships or partnerships where all profits are subject to self-employment tax.

Paying an S Corporation owner involves setting up formal payroll to ensure proper withholding and remittance of payroll taxes. Distributions are made separately as non-payroll transfers, reflecting the owner’s share of the company’s remaining profits. This two-tiered payment system allows S Corporation owners to minimize their tax burden by reducing the amount of income subject to self-employment taxes.

Owner Payments for C Corporations

C Corporations are distinct legal and taxable entities, meaning the business itself pays corporate income tax on its profits. For owners who also work for the company, the primary method of compensation is a W-2 “salary.” This salary is a deductible business expense for the corporation, reducing its taxable income.

Unlike S Corporations, C Corporations face “double taxation” if profits are distributed as dividends. This occurs because the corporation first pays income tax on its profits, and then shareholders pay individual income tax on the dividends received. Dividends are paid from the corporation’s after-tax profits and are not deductible expenses for the business.

Similar to S Corporations, paying a C Corporation owner-employee involves establishing a payroll system for tax withholding and reporting. Dividends, when declared, are paid as a separate transaction to shareholders. The decision to pay dividends depends on the corporation’s profitability and its strategy for retaining earnings versus distributing them.

Maintaining Proper Records for Owner Payments

Record-keeping is important for all business owners regarding owner payments, regardless of their entity structure. Records serve as documentation for tax compliance, accurate financial reporting, and preparing the business for potential audits. For every payment made to an owner, details must be recorded.

These details include the date, amount transferred, specific purpose (e.g., owner’s draw, salary, distribution, guaranteed payment), and the business account from which funds were disbursed. Accounting software can streamline this process by automating transaction categorization and generating financial reports. Maintaining bank statements and retaining payroll records, particularly for S Corporations and C Corporations, provides verifiable proof of transactions. Organized record-keeping ensures financial transparency and adherence to regulatory requirements.